Stick, who runs the five FE Crown-rated Rathbone Income fund, warns investors about the dangers of relying on an “easy narrative”, which may seem to offer an explanation of why a stock is attractive but runs the risk of making it difficult to recognise when their investment case has been compromised.The manager, whose £896.1m portfolio appears on the FE Research team’s Select 100 list of recommended funds, has been reducing exposure to two former favourite businesses on the back of concerns that their performance is not in line what would be expected from their investment rationales.
“Years ago I fell over and broke my arm. I remember telling people at the hospital how I broke it and that was the truth.”
“But over a period of time, the memory of it sort of got distorted and became a story, a narrative.Even now I can’t remember exactly how I broke my arm – all I remember is the story I told people,” the manager said.
“It’s a bit like that with investment - you make a decision to buy a business as you have an investment rationale that is very valid, you’ve worked it through and done your analysis.”
“But over time it’s inevitable that a degree of complacency comes in behind that easy narrative. You have a story: ‘This is why we own this particular stock, for reasons a, b, c and d.’ They become easy bullet points to put into a presentation.”
“Before you know it, you’re hiding behind that story - you don’t question it [and] it becomes a mainstay of the fund. It’s really important when you’re thinking about sell discipline to have rules in place to stop that complacency setting in and to avoid building an easy narrative around an idea.”
Performance of fund vs index and sector over 5yrs
Source: FE Analytics
Multinational alcoholic beverages company Diageo used to be one of Rathbone Income’s largest holdings, making up about 6 per cent of the portfolio around five years ago.
However, Stick has been reducing the stock over the past couple of years and has recently taken his exposure to less than one per cent.
Since it was founded in December 1997, Diageo’s share price has rocketed, surging 426.54 per cent against the 129.03 per cent rise in the FTSE 100.
However, performance over recent years has been more muted with the company gaining just 5.90 per cent since the start of 2013, compared with a 21.04 per cent advance in the blue-chip index.
“Diageo is an absolutely astounding business but it is a very good example of how things change,” the manager said.
“It was a great story to talk about. You can’t recreate Diageo - you have centuries of work going into Johnny Walker, centuries of tradition around Guinness. If you gave a business $20bn or $30bn of capital, it would not be able to recreate Diageo. What an easy story to present to the outside world and show you flashy pictures of their brands.”
“But the reality is different.”
Performance of stock vs index since December 1997
Source: FE Analytics
Stick has elected to sell down his holding in the company because it has invested capital “less wisely” over recent years, which has pushed down its cash return on assets.
The firm has acquired or taken large stakes in firms such as Chinese spirit producer Shui Jing Fang, Turkish enterprise Mey Icki and India’s United Spirits but Stick argues that “too high a price has been paid for too low a return”.
“A lot of money has gone into this businesses and yet returns are decreasing. By our rules I can’t just ignore that and I can’t hide behind the wall of an easy argument,” he added.
“We realised that when you take that investment away from the business, cash doesn’t cover the dividend. That isn’t going to be sustainable. The analysis we have done and the rules we set ourselves mean we have to question whether or not our initial narrative still stands. The answer was no.”
“It was a difficult decision to make but we’re not convinced this is the best place to put clients’ money when looking at future returns and dividend growth.”
Stick has also been reducing exposure to GlaxoSmithKline, the largest position in the fund. In March this year, Rathbone Income had 5.89 per cent of its portfolio in the pharmaceutical giant but this was lowered to 4.78 per cent by the end of August.
The manager points out that the old investment narrative for the stock revolved around growing the top line by 1 to 2 per cent a year, improving the margin through cost efficiencies and diversifying product ranges while reducing reliance on blockbuster drugs.
“But ever so slowly the story has changed,” the manager said in his latest update.
“Glaxo sold the Ribena and Lucozade drinks brands to Japanese firm Suntory for £1.35bn in September last year. OK, not a big issue, but a bit of a U-turn. More worryingly, the company is rather more beholden to blockbuster drugs than we surmised.”
Although chief executive Andrew Witty is encouraging analysts to look beyond this year and focus on what GlaxoSmithKline will look like in three years, its business model appears under stress and some analysts have argued the safety of its dividend could be under question.
“When we assess GSK as an investment, there are more business risks than were apparent two or three years ago,” Stick said.
Rathbone Income has a clean ongoing charges figure of 0.80 per cent and is yielding 3.50 per cent.
Since Stick took over the fund in January 2000, it has returned 249.64 per cent against the 134.44 per cent return of the average IMA UK Equity Income fund and the 83.19 per cent rise in its FTSE All Share benchmark.
Over five years, it has gained 85.25 per cent - outperforming the sector’s 69.99 per cent and the index’s 62.80 per cent.
Performance of fund vs sector and benchmark since Jan 2000
Source: FE Analytics
The FE Research team highlights the fund has an option for cautious investors, as Stick has experienced many different economic and market conditions over his tenure on the portfolio and has progressively refined his approach to UK equities.
“The manager invests in companies for the long term, meaning portfolio activity is low. Stick prefers to stay away from companies that are gaining momentum, instead preferring those that seem out of favour,” the team said.
“Therefore the fund will not be the best performer in a fast-rising market, but will effectively protect investors’ capital in a falling one.”
